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Writing off losses in your portfolio

By Walter Updegrave, senior editor


(Money Magazine) -- Question: If I sell a mutual fund to write off the loss on my tax return, do I face any restrictions on reinvesting the money? -- Tom M., St. Paul, Minn.

Answer: Despite this year's market rally, many people are still sitting on mutual funds, stocks, or other securities that are worth less than they paid for them. So your question serves as a good last-minute reminder that investors in this position who sell for a loss before the end of the year might be able to trim their 2009 tax bill.

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Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005)

I say "might" because I know from experience that there are some people out there with beaten-down 401(k)s and IRAs who mistakenly think that they can harvest losses for tax purposes within those accounts.

Alas, while it's technically possible to deduct losses in tax-advantaged accounts, the situations under which you may actually do so are pretty limited. And even if you are able to write off a loss in an IRA or 401(k), it's debatable whether it would pay to do so.

But if the mutual fund you're hoping to unload at a loss is in a taxable account, then you should be able to pull off the tax-loss sale fairly easily. Okay, "easily" may be going too far. Since our tax code is involved, there are a number of nitpicky little rules you must follow to establish and take advantage of a capital loss. And there are a few extra twists when it comes to mutual funds.

But if you check out this earlier column I wrote that outlines the process, you should be able to take the loss and first use it to cancel out other realized gains you may have. If you still have a loss after doing that, you can apply up to $3,000 of it against regular income. If you still haven't soaked up the entire loss, you can carry it forward to future years.

Now, as to your question about restrictions on reinvesting the process of the sale. You're free to invest however you like. But if want to deduct the loss, you have to make sure that you don't run afoul of the IRS's "wash-sale" rules.

Basically, if you buy the same or "substantially identical" security 30 days before or after the sale to establish the loss, the IRS will disallow part or all of the loss. The particulars of the wash-sale regs, as well as all the other niceties you need to know about selling for a tax loss, are spelled out in excruciating detail in IRS Publication 550.

Oh, and don't try to get cute by having your spouse purchase the fund you're selling to establish a loss or by buying the fund in your IRA. The IRS has made it clear that this tactic is a no-no.

One final thing. As long as you're going through your holdings for securities to unload, why not also take the opportunity to rebalance your portfolio? That way, you'll get a nice tax break, and head into the New Year with a well-tuned portfolio at the same time.

Are you stuck in a lousy 401(k) plan at work but want help maximizing your retirement savings? Send us an email at makeover@moneymail.com. For the CNNMoney.com Comment Policy, click here.  To top of page

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